Is PolyNovo (ASX:PNV) Using Debt In A Risky Way?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies PolyNovo Limited (ASX:PNV) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for PolyNovo

What Is PolyNovo's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 PolyNovo had debt of AU$7.43m, up from none in one year. However, its balance sheet shows it holds AU$7.71m in cash, so it actually has AU$280.4k net cash.

How Strong Is PolyNovo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PolyNovo had liabilities of AU$6.52m due within 12 months and liabilities of AU$7.77m due beyond that. On the other hand, it had cash of AU$7.71m and AU$3.85m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.73m.

Having regard to PolyNovo's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$1.84b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, PolyNovo also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PolyNovo's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, PolyNovo reported revenue of AU$25m, which is a gain of 35%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is PolyNovo?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that PolyNovo had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$7.4m of cash and made a loss of AU$5.3m. Given it only has net cash of AU$280.4k, the company may need to raise more capital if it doesn't reach break-even soon. PolyNovo's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting PolyNovo insider transactions.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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